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Welcome to our series – Crypto Money Laundering Explained – where we break down individual risk categories and help you learn how criminals use digital assets and the mechanisms involved in laundering the proceeds of crime.
In this issue, we explore how bad actors use crypto exchanges to launder illicit funds and how blockchain analytics can be used to counter them.
As key infrastructure providers in the crypto ecosystem, cryptoasset exchanges play a fundamental role in the day-to-day operation and growth of the industry. By allowing users to easily buy, sell and trade cryptocurrencies, exchanges are often a stepping stone for new cryptocurrency users as they engage in the sector.
While many exchanges go to great lengths to achieve cryptocurrency compliance, others lack the analytical tools, policies, procedures, or desire to prevent engagement in criminal activity. This means that they provide criminals with the perfect opportunity to successfully launder crypto assets exposed to illegal activities.
Here’s how it happens:
Scenario 1: Using non-compliant cryptoasset exchanges
Using non-compliant exchanges that fail to implement effective anti-money laundering (AML) and know-your-customer (KYC) controls, criminals can easily exchange their illicit cryptocurrencies for fiat and other crypto-assets without revealing their identity. This makes the identification of individuals or organizations behind criminal activity much more difficult for law enforcement and enables successful asset laundering.
Cryptoasset exchanges that do not meet global compliance standards can present potential exposure to both criminal activity and sanctioned entities. Counterparties dealing with these organizations may also be considered high risk and, depending on their level of exposure, may exceed the risk thresholds of the legitimate organizations with which they attempt to engage. This can essentially lock them out of the legitimate crypto ecosystem and prevent them from cashing out.
Scenario 2: Using cryptoasset exchanges in high-risk jurisdictions
Exchanges located in high-risk jurisdictions may have little regulatory oversight and offer criminals a simple and easy way to launder illegal cryptocurrency.
Most blockchain analytics tools will automatically assign high risk scores to these exchanges – and the individuals who deal with them – due to the ease with which they allow criminals to successfully launder cryptocurrencies.
Scenario 3: Using banknotes or fake documents to bypass the compliance process of cryptoasset exchanges
While the greatest risk comes from exchanges that do not have proper compliance systems in place, some criminals use money mules or fake letters of credit to engage in false assumptions.
These mules open accounts on legitimate exchanges, which are then used to channel the proceeds of crime. Often, these accounts will receive multiple high-value transactions from high-risk jurisdictions or from individuals linked by common characteristics, such as IP address or nationality. These factors can arise when crypto researchers follow a potential red flag and dig deeper into a client’s source of funds using blockchain investigation tools.
How cryptoasset exchanges use blockchain analytics
Cryptocurrency exchanges use blockchain analytics to monitor transactions and wallets, ensuring that their customers and other parties they deal with are not exposed to illegal activity.
Blockchain analytics solutions integrate directly into the exchange’s technology stack, so these checks happen automatically at scale when new deposits are made and payments are sent. This ensures a seamless user experience, without compromising security.
Why Blockchain Analytics Matters
Each of these unique scenarios highlights why it’s important to have the right blockchain analytics solutions. Firms must be able to automatically screen exposure to high-risk exchanges that do not adhere to compliance standards and effectively identify whether they are located in a jurisdiction with a history of facilitating illegal activity. These factors will determine the actions you take when you come into contact with the entity. In the event that red flags appear, you need an intelligent blockchain tool to further investigate and evaluate any signs or behaviors that may suggest illicit funds are involved.
These are all fundamental capabilities needed to enact a successful cryptocurrency compliance strategy and should play a role when choosing your blockchain analytics solution.
Learn more about crypto risk categories, their associated red flags and how to counter them in our comprehensive 2023 “Typologies Report”.
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